The Safety of Academia

Yesterday afternoon the Hedgeye foot soldiers of the independent research gridiron rolled out of 111 Whitney to Luce Hall Auditorium for a 4PM roundtable discussion on “US Financial Reform: The Dodd-Frank Act – Will It Work?” The Moderator was Ernesto Zedillo (34th President of Mexico) and the participants were Robert Shiller (Yale), Thomas Cooley (Stern School of Business), and Stephen Roach (Morgan Stanley).

Until Roach started laying into some of academia’s Perceived Wisdoms about modern day risk management, it was a moderately boring event. It took Zedillo 13 minutes to introduce the financial crisis and pump Cooley’s recent books, then he handed it off to Shiller and Cooley whose main contributions to the debate were to A) support Dodd-Frankenstein and B) mock anyone who has worked at the Whitehouse who doesn’t have a Ph.D. in economics.

Now I’m a big fan of both mocking some of the financial academics in the West Wing and of Robert Shiller’s mean reversion work. He was my professor here at Yale in the mid-90s and I’m not going to ride his love-boat this morning, but he is one of the most important Risk Managers of modern day bubble making in the Fiat Republic.

Shiller made me smile when he acknowledged that Barney Frank was a poli-sci Ph.D. dropout and has certain barriers of competence on financial risk management matters. Pleasantries aside, Shiller’s idea that America’s economic resolve is going to be found within the Safety of Academia made me nauseous.

I certainly don’t always agree with Steve Roach, but his basic conclusion on Dodd-Frankenstein was that “it’s a framework” that will render itself an “insufficient solution” to this economic mess. While Tom Cooley was mocking the likes of Treasury Secretaries who don’t come from the Safety of Academia, Roach (who has his Pd.D. from NYU) was quick to remind him that the biggest joke of all is watching their academic colleagues at a G-20 summit talk about real-time markets. Zedillo didn’t like that.

While Shiller and Cooley were focused on whether or not Dodd-Frankenstein Reform would have prevented Lehman Brothers from imposing systemic risk on the US financial system, Roach was more concerned with its ability to prevent the next financial crisis. I agree with Roach’s main conclusion on the root cause of the US financial system becoming as compromised as it has - US monetary policy. Zedillo didn’t like that either.

Shiller didn’t disagree with Roach on the Fed’s impact. Thank God. But the former Mexican Secretary of Education (Zedillo), didn’t like Roach going after another highly regarded academic (Ben Bernanke). This is the debate that needs to be had in this country. Is the root cause of all our leverage and liquidity problems simply the implementation of an academic ideology that monetary policy should only be used as a blunt instrument on the way down and not on the way up?

Roach knocked the pins down pretty convincingly on what the Federal Reserve’s objectives should be:

Full employment (1946 Employment Act)

Price Stability (1976 Humphrey-Hawkins Act)

Financial Stability (2010 Dodd-Frankenstein, God help us Act)

On Full Employment (economic growth) and Price Stability (inflation), it’s very hard to argue that the last decade of America operating under the Greenspan/Bernanke academic ideologies has worked (net American private sector job adds in the last decade has been ZERO).

This shouldn’t be a surprise, neither Greenspan nor Bernanke saw any success applying their academic theories as practitioners of real-time risk management. Volcker’s decade (1980’s, where net private sector job adds was +18 MILLION) was much more successful on both the Full Employment and Inflation scores.

On Financial Stability, I don’t think Dodd-Frankenstein supporters have any legitimate claim at this point that it can supersede or contain the long term TAIL risks that the current monetary policy of our Fiat Republic imposes. As both Harvard’s Ken Roggoff and Yale’s John Geanakoplos have both recently concluded, understanding financial crises starts and ends with the cycle of leverage.

The US Federal Reserve and the Bank of Japan (and now the European Central Bank) have all attempted to manipulate the cost of and access to that leverage. Since Paul Krugman used his economics Ph.D. to advise the BOJ to “PRINT LOTS OF MONEY” in 1997, the Safety of Academia hasn’t shown this modern day Risk Manager with a BA in Economics something that’s actually worked.

I continued to intervene in the Hedgeye Portfolio yesterday, reducing risk by making more sales on this market’s immediate term TRADE strength. In the last 48 hours I’ve gone from a mix of 14 LONGS/7 SHORTS to 13 LONGS/10 SHORTS. That’s the only way to protect my family and firm from the failed policy makers of this world who keep coming up with new policies to creatively destruct our economic liberty.

My immediate term support and resistance levels for the SP500 are now 1107 and 1131, respectively.

Best of luck out there today,

KM

Keith R. McCulloughChief Executive Officer

Share

Print

09/16/10 06:54 AM EDT

MACRO: Are We Bearish Enough On the Dems....

Are We Bearish Enough On the Democrats Heading into the Midterms?

Last week we hosted a call with Karl Rove, former Deputy Chief of Staff at the White House, to discuss whether the midterm elections could be a major stock market catalyst. Our basic premise heading into the discussion was that if the Republicans gain enough seats, it would be a strong repudiation of the Obama administration’s economic policies and, potentially, lead to an extension of the Bush Tax Cuts, both of which would be positive for the stock market in the short term.

The discussion with Mr. Rove was fascinating on many levels, but most importantly it gave us an opportunity to pick the brains of one of the more successful political strategist of the modern era. Whether you like his politics or not, Rove has won many elections. In fact, of the more than 40 races that he has been the primary strategist for, he has won more than 80% of them. A key take way from our discussion with him was that trends matter in elections, and they are difficult to overcome in a short period of time. Further, the direction of these trends is a leading indicator for the next electoral data point. (Sound a bit like the stock market?)

While polls on an individual basis can be wrong, in aggregate they typically provide compelling insight into the electoral landscape. Currently, we are focused on four specific polls whose trends make us believe that we may not be bearish enough on the prospects for Democrats in the midterm elections. Specifically, these polls are: Presidential job approval, the generic congressional ballot, approval of Congress, and enthusiasm for voting.

Presidential Job Approval

This poll is the best proxy for how the President has been doing, and while his approval may not be a function specifically of his policy (i.e. the economy which he can’t control could be the issue), it is a reflection of how he is being perceived. The Real Clear Politics poll aggregate currently shows President Obama with a -2.5 spread on approval, which is the difference between Approve (46.6) and Disapprove (49.1). While this isn’t quite the lowest rating of his Presidency, it is right near the bottom. More importantly, he started his Presidency with a +44.2 spread and the trend since his election has been straight down.

The key implication of a negative approval rating for the President heading into the midterms is that Democrats will try to distance themselves from him, and in doing so won’t be able to use the natural fund raising and bully pulpit abilities that come along with the President campaigning on your behalf.

Generic Congressional Ballot

The Generic Congressional Ballot measures which party those polled would vote for if the choices were generic. According to the Real Clear Politics Aggregate, the Republicans have +7.8 advantage over the Democrats in this poll based on spread of 48.1 to 40.3. This is noteworthy given that in Obama’s first week in office this same measure had the Republicans at 34 and the Democrats at 48 for a +14 point Democratic advantage. This is an amazing reversal for the Republicans as we’ve seen an almost 22 point swing in preferences in just two years.

Approval of Congress

As we’ve been writing for months to our clients, the anti-Washington sentiment is as high as it has ever been in this country. The best measure for this is approval for Congress. Currently, and once again according to the Real Clear Politics Aggregate, almost 72% of those polled disapprove of Congress, while only 23% approve. This is a clear and strong statement against incumbency and since the Democrats current control the Presidency, the Senate, and the House, they are overwhelmingly viewed as the incumbents.

Voting Enthusiasm

One of the best polls we’ve seen for evaluating voter enthusiasm is the Gallup Poll that measures the “thought given to the election” by those polled. In the most recent results from this poll on September 2nd 2010, 54% of Republicans indicated they had given some thought to the election, compared to only 30% of Democrats and 32% of Independents. This is in stark contrast to this poll during the last midterm, which showed Republicans slightly lower at 53%, but the Democrats at 52%. Amazingly, the current spread between Republicans and Democrats on the measure is 24 points, which is the widest Gallup has ever measured in this poll going back to 1994.

While some Republican Party officials have recently been talking down their chances in the midterms, the numbers in the polls outlined above and in the table suggest just the opposite. In aggregate, Republicans are motivated, are being clearly favored by registered voters, and do not have the disadvantage of being led by an unpopular President. Moreover, these measures have all been trending in the favor of the Republicans for the last two years and will, absent an October surprise, likely continue to do so through the midterms.

There is a consensus view, which was shared by Mr. Rove in our discussions, is that the Republicans will take back the House of Representatives and likely not wrest control of the Senate. The question in our minds after reviewing the data and trends is: are we bearish enough on the Democrats heading into the midterms? We think not. In fact, the real October Surprise will likely be a historic win for the Republicans in which they have a strong majority in the House and take back the Senate.

That being said the wild card remains the Tea Party and their influence on the primaries as we are seeing today in Delaware with the success of radical candidate Christine O’Donnell who won the Republican nomination. As our friend Mr. Rove said last night about this victory:

“It does conservatives little good to support candidates who, … while they may be conservative in their public statements, do not evince the characteristics of rectitude and sincerity and character that the voters are looking for. … There’s just a lot of nutty things she’s been saying. …”

Indeed.

Daryl G. Jones Managing Director

Subscribe to Hedgeye to receive research and portfolio positions in real-time.

Sticking With Our Yen Short

Position: Short the Japanese yen (FXY);Long the Chinese yuan (CYB)

On Chinese yuan manipulation: “Frankly, they haven’t let the currency move very much so far… They know they’re just at the beginning of that process and I think we’d like to see them move more quickly.”

On Japanese yen intervention: “They’re working through some difficult problems… My view is they should be focusing like we are on how to make sure they’re reinforcing recovery in Japan and doing things that are going to help.”

Both statements we’re made just last week by the same person – U.S. Treasury Secretary Tim Geithner. While we could spend quite a few paragraphs highlighting the hypocrisy embedded in these contrasting stances, we’d rather tackle today’s Japanese FX market intervention from a more analytical standpoint.

For the first time since 2004, Japan intervened in the currency market in an attempt to stem an 11%+ gain since mid-May, which caused the yen to tumble ~3% - a large intra-day move for a currency of this size and liquidity. Until today, the yen hadn’t eclipsed 85 per dollar in almost two weeks.

Yesterday we added to our short FXY position in our Hedgeye Virtual Portfolio, reinforcing our conviction that Japanese policy makers will do what they’ve done for two decades – intervene in financial markets. Should the latest round of intervention prove unsuccessful in reversing the recent up-trend, we anticipate further intervention from here. Our confidence lies in both the economic fundamentals and the rhetoric put forth by Japanese politicians in the weeks leading up to today:

Japan’s 2Q GDP rolled sequentially: +1.2% SAAR. vs. +4.98% in 1Q

Deflation intensified in July: (-0.9%) YoY vs. (-0.7%) in June

Japanese Industrial production fell in July after being revised down: (-0.2%) MoM vs. +0.3% prelim.

Export growth slowed in July: +23.5% YoY vs. +27.7% in June

8/27: Japanese Prime Minister Naoto Kan: “We will take bold action if necessary and naturally that can include intervention… We have to use every option available as a strong yen is likely to have a severe impact on companies.”

9/8: Japanese Finance Minister Yoshihiko Noda: “We will take bold action if necessary and naturally that can include intervention [in the FX market]… We have to use every option available as a strong yen is likely to have a severe impact on companies.”

Kan’s election victory over Ozawa was by a slim margin among Japanese legislators (+6 votes). This meant he would have to relinquish on the margin his relative fiscal hawkishness and conform to Ozawa’s “support the economy by any means necessary” approach if he is to maintain stability within the DPJ.

Today: Japanese Finance Minister Noda: “We will continue to watch developments in the market carefully and we will take bold actions including further intervention if necessary.”

To be crystal clear, however, we aren’t short the yen purely based upon the catalyst provided by the current batch of Fiat Fools leading Japan. We think the top in the yen is around yesterday’s pre-intervention level of 82-83 per dollar and we see downside on a 3-6 month go-forward basis around 6-9%.

The reasons for our bearish stance are: the potential for both waning upward Chinese pressure on the yen and U.S. dollar stability.

We’ve been vocal in recent weeks highlighting the shift by China into short term JGBs an out of short term U.S. Treasuries. The most recent data for both confirm this trend:

China bought more bonds than it sold in July for the seventh straight month: 583.1 billion yen vs. 457 billion yen in June – a sequential acceleration. Reports from Japanese banks suggest the incremental holdings to be comprised of mostly short term JGBs.

China’s holdings of short term Treasury bills fell further in June, giving the securities a 98% peak-to-trough decline within China’s FX reserves.

Why would China seek to pump up the yen on such short notice? There are two reasons, one of which is linked directly to Tim Geithner’s comments mentioned above. By forcing Japan to intervene in the FX market, China can either hope that Japan’s intervention will alleviate pressure from U.S. Congress to expedite the appreciation of the yuan. Should the finger-pointing persist, China now has a stronger case for resistance, pointing out the U.S.’s aforementioned hypocritical stance on currency manipulation. As recently as today, China's Ministry of Commerce said that its trade policies shouldn't be dragged into U.S. electioneering and rejected criticism of the yuan's value as "groundless".After imposing duties on Chinese-made steel pipes Monday, the U.S. Department of Commerce is meeting today and tomorrow to discuss China’s currency policy. After Japan’s actions today, we don’t expect the findings of this meeting to provide any meaningful incremental pressure on the yuan.

Another reason China may want to allow the yen to appreciate is to alleviate competitive pressure as it slowly allows the yuan to appreciate to combat inflation – Chinese CPI accelerated in August: +3.5% YoY vs. +3.3% in July. Today, the yuan touched 6.733 per dollar, which is the strongest level since the central bank unified the official and market exchange rates in 1993. Further, it has strengthened 0.8% in the past five days alone.

As previously mentioned, a second tenet to our bearish view on the dollar is the potential for dollar stability based on fiscal restraint and foreign central bank dollar buying. According to our proprietary models (which were designed using the specific analytic insight of Karl Rove), we expect the Republicans to take control of the House and for them to win 49 or more seats in the Senate – more than currently estimated by consensus. We feel this marginal shift towards fiscal conservatism out of Congress post the midterm elections will provide much needed support for the U.S. dollar, which has lost ~8% of its value since its cycle peak on June 7.

To find evidence of accelerated foreign central bank dollar buying, one needs to look no further than Brazil – though there are certainly many other countries expressing similar concern. Brazil’s central bank held two daily auctions on three days last week to buy dollars, marking the first time since May that it opted for more than one round of purchases. This is on the heels of Brazilian Finance Minister Guido Mantega’s vow last week to not allow the real to continue appreciating. Korea and Malaysia are two more Asian nations (in addition to Japan) that are expressing concern over recent appreciation.

In short, we stand counter to consensus that the yen will continue it March upward. While a pullback to the 82-83 level is likely in the near term, the 3-6 month outlook for USDJPN is decidedly bearish.

Darius Dale

Analyst

Share

Print

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

CHART OF THE DAY: U.S. INDUSTRIAL PRODUCTION

The CHART OF THE DAY below stands behind my 14th bearish point of the day and should illicit plenty of questions in any risk managers mind about go forward US growth expectations. US industrial production “comps” only get tougher from here – that doesn’t mean we are calling for a newsy “double dip” (which implies negative Q3/Q4 US GDP growth), but it definitely suggests US GDP growth can continue to drop sequentially for the next 3-6 months.

I’ll leave you alone with that red arrow to noodle over for today. KM

All notes posted in the unlocked research section are posted on delay. Subscribe to receive our research and portfolio ideas in real-time.

Net net, we’ve started making some sales in the last 24 hours in the Hedgeye Portfolio (12 LONGS, 8 SHORTS vs. 14 LONGS 12 SHORTS yesterday) and we’ve taken some beta out of our Hedgeye Asset Allocation Model (selling Cocoa/Commodities, buying Bonds).

Finally, the CHART OF THE DAY below stands behind my 14th bearish point of the day and should illicit plenty of questions in any risk managers mind about go forward US growth expectations. US industrial production “comps” only get tougher from here – that doesn’t mean we are calling for a newsy “double dip” (which implies negative Q3/Q4 US GDP growth), but it definitely suggests US GDP growth can continue to drop sequentially for the next 3-6 months.

I’ll leave you alone with that red arrow to noodle over for today. KM

All notes posted in the unlocked research section are posted on delay. Subscribe to receive our research and portfolio ideas in real-time.

II Bullish to Bearish Survey has popped 1500 basis points to the bullish side of the ledger in the last 3 weeks with Bulls up 400bps w/w to 37%

Tea Party wins in NY, Delaware, etc last night impose a headwind to the consensus/expected Republican romp at midterms

US Industrial Production growth reported this morning slows sequentially for the 3rd straight month to 6.2% (AUG) vs 7.4% (JULY)

Net net, we’ve started making some sales in the last 24 hours in the Hedgeye Portfolio (12 LONGS, 8 SHORTS vs. 14 LONGS 12 SHORTS yesterday) and we’ve taken some beta out of our Hedgeye Asset Allocation Model (selling Cocoa/Commodities, buying Bonds).

Finally, the CHART OF THE DAY below stands behind my 14th bearish point of the day and should elicit plenty of questions in any risk managers mind about go forward US growth expectations. US industrial production “comps” only get tougher from here – that doesn’t mean we are calling for a newsy “double dip” (which implies negative Q3/Q4 US GDP growth), but it definitely suggests US GDP growth can continue to drop sequentially for the next 3-6 months.

I’ll leave you alone with that red arrow to noodle over for today.

KM

Share

Print

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

Thank You!

Your request has been received

You have been added to our list and will receive an email shortly.

If you do not receive an email, please check your spam filter, and then email
support@hedgeye.com.
By joining our email marketing list you agree to receive emails from Hedgeye. This is a distinct and separate service form any of our paid service products. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.